RBS Securities, the Royal Bank of Scotland’s US trading business, was mentioned only four times in the UK bank’s 543-page annual report for 2012 – and briefly at that.

It is unlikely to figure very prominently in the 2013 annual report, which will be released this month. Nor, one suspects, will Ross McEwan, the new chief executive, dwell long on it when he outlines his strategic vision for the bank. This is odd; the decisions that will soon have to be made about the unit – formerly known as Greenwich Capital – could be instrumental in deciding the future shape of the whole group.

Why is the Royal Bank of Scotland so coy about one of its most successful businesses? And why is RBS Securities – safely tucked away in Stamford, Connecticut, and rarely discussed in polite society – so strategically pivotal? Taken together, the answers to these questions encapsulate the scale of McEwan’s challenges.

History repeats

The New England-based business played a central role in both the rise and fall of Royal Bank of Scotland. Greenwich Capital Markets was bought by National Westminster Bank in 1996; NatWest was, in turn, bought by RBS in 2000. During the debt-driven bull years that followed, Greenwich prospered – fuelling RBS’s hubris and acquisitive zeal. It then ensured the whole fandango came to a shuddering halt by diving headlong into the collateral debt obligations market in 2006.

But, despite being ground zero for many of the UK bank’s woes, the Greenwich business quickly recovered. In 2011, RBS’s investment bank (then called global banking and markets) made 36% of its money in the US (only 27% of the unit’s revenues were made in the UK), according to an investor presentation in March 2012. (Unfortunately there are no records on the RBS website of any such presentation last year – so these are the most up-to-date figures available.)

The awkwardness comes in how that money was made. Of the $3.4 billion in revenues generated in the US in 2011, only $640 million came from banking and $2.8 billion from the markets division. Of that $2.8 billion, by far the majority ($1.5 billion) was made trading asset-backed (read: mortgage-based) products.
In other words, as recently as two years ago, the investment banking division of Royal Bank of Scotland was making more money dealing in risky mortgage-backed products in the US than anything else – not a situation likely to delight its largest shareholder, the UK government.

No wonder RBS likes to keep this particular light hidden under a bushel.

Related

The relative importance of RBS Securities is likely, if anything, to have increased over the past two years as Fred Goodwin’s empire has been slowly but methodically dismembered. Since the beginning of 2012, RBS’s investment bank has shed more limbs than the Black Knight in Monty Python and the Holy Grail. It has wound down its cash equities and equity capital markets offering (“’Tis but a scratch”), lopped off its mergers and acquisitions units (“I’ve had worse”), sold its UK corporate broking arm Hoare Govett to Jefferies (“Have at you!”) and, in November last year, handed over its retail investor products and equity derivatives business to BNP Paribas (“Just a flesh wound”).

All that’s left is a defiant torso: international banking run by John Owen and the markets business co-headed by Peter Nielsen and Suneel Kamlani. And the beating heart of the markets business is RBS Securities’ 95,000 square foot trading floor in Connecticut.

No easy answers

All of which leaves McEwan with a fair number of tricky questions to answer.

The New Zealander must decide between two political imperatives: turning RBS into an ultra-orthodox, UK-focused bank or increasing the share price to a point where the UK government can sell off its stake.

Are those two aims mutually exclusive? Not totally, but it’s close. Getting rid of the turbo-charged US trading business would almost certainly delay the day when UK taxpayers get (at least some of) their money back. RBS can be made safer, but there’ll be a price tag attached.

Next, what kind of wholesale banking capability does the chief executive, who used to run the retail banking division, want to maintain? Despite everything, RBS still boasts the most profitable corporate banking franchise in the UK. But the simple fact is that if RBS wants to provide a full range of services to those corporate customers it needs to maintain a markets business. And if it wants to maintain a markets business it needs – as lots of other European banks have recently acknowledged – a strong foothold in the US. (This question is further complicated by the fact that no one yet knows for sure which wholesale banking activities might fall within a Vickers ring fence).

While we’re on corporate banking, it is worth bearing two things in mind: first, as UK and European companies eschew bank loans for the capital markets, being able to tap the world’s largest pool of debt investors on the other side of the Atlantic might come in handy. And, second, UK businesses tend to venture abroad to source supplies or sell their wares from time to time. RBS won’t remain the most profitable UK corporate bank for long it if has to wave its clients adieu at passport control (which is why McEwan also needs to think carefully about what to do with the bank’s international network – the final husk of what was bought so dearly from ABN Amro in 2008).

Even if the siren voices in the Treasury prevail and McEwan is forced to sacrifice RBS Securities, he’ll face yet more tough decisions. Should RBS want to retain, say, some foreign exchange and simple derivatives capability, it will have to start teasing apart the various strands of the markets business. This could end up making it a far less attractive proposition to prospective buyers.

One thing’s for certain: the Kiwi banker is really going to be earning that bonus he’s already turned down.
Pronouncements by RBS chief executives have long been as much about politics as business. That is why McEwan is unlikely to say much, if anything, about RBS Securities in public. But you can be sure that, behind closed doors – in the bank’s City headquarters, in Westminster and in Connecticut – the unit’s future is being discussed in earnest.